The Co-Operative Group could virtually double its “non-core” commercial real estate (CRE) loan book to £4bn as part of a wider set of measures designed to boost the troubled mutual’s tier one capital by £1.5bn in the next 18 months, paving the way for potential loan portfolio sales of the bank’s performing and non-performing pools.
Already, the Co-Op has a pool of £2.1bn impaired real estate loans – comprised £1.74bn in commercial property loans and £300m in residential loans as at 21 March – categorised as non-core and earmarked for sale or run-down.
However, following today’s balance sheet restructuring agreement with members and bondholders, this could rise to include the remaining £1.9bn “core” CRE exposure.
This morning, the Co-Op outlined – only in broad terms – a balance sheet recapitalisation strategy, which will aim to raise £1.5bn in tier one capital through a debt-for-equity swap by holders of £1bn of the bank’s junior debt, as well as the sale of already identified non-core asset sales or run-downs.
As part of this restructuring strategy – which will raise £1bn in tier one capital this year and another £500m next year – the UK’s largest consumer mutual bank stated this morning that “the bank will also be treating as non-core larger corporate and commercial customers”.
By definition, this grouping of its SME clients at least partially includes the Co-Op’s £1.9bn previous-defined core CRE loan book, and this could rise further still to include the entire performing CRE loan book by the time the bank announces its detailed de-leveraging strategy at its end of August interim results.
Crucially, the Co-Op stated this morning that any sale of the bank’s non-core assets “including potentially via selected asset sales where such sales do not materially reduce the core capital ratio of the bank”.
That is, the Co-Op is only a seller at levels which are tier one capital accretive, not erosive.
This, of course, does not mean the Co-Op would have to sell at par, but at a shallow discount for performing assets, comparable with Commerzbank’s imminent sale of the performing component of the Eurohypo UK commercial property loan book to Wells Fargo, believed to be in the mid-90s in the pound.
Similarly, Deutsche Bank is contemplating the sale of Deutsche Postbank’s €2.5bn UK commercial property loans book, the retail deposit bank subsidiary it majority owns.
By contrast, the expected sale of the Co-Op’s impaired CRE loan book is likely to crystallise further losses than already booked, given the expected continued deterioration since the sub pool was last reported, nearly three months ago.
This £2.1bn impaired real estate loan book is subdivided as follows:
- 12 loans with an outstanding balance of £936m, against a carrying value of the assets of £696m, reflecting a 25.6% write-down to date by the Co-Op. At the end of March, £193m of impairment provisions had been taken which, together with the carrying value, leaves £47m to be sourced through property performance.
- Remaining loan portfolio with an unpaid principal balance of £803m, against a carrying value of the assets of £305m, reflecting a 62.0% write-down to date by the Co-Op. At the end of March, £341m of impairment provisions had been taken which, together with the carrying value, leaves £157m to be sourced through property performance.
The Co-Op also re-confirmed that all new commercial property lending has ended, and only existing core customers will be considered for loan renewal on a case-by-case basis until an August announcement of its longer-term strategy for UK property lending.
In mid-May, CoStar News outlined a detailed analysis of the Co-Op’s commercial real estate de-leveraging options undertaken by Morgan Stanley, which analysed the relative merits for best possible capital recovery for the Co-Op’s impaired property loan book: including a disposal of the loans by portfolio sale, underlying asset sales and running-off the book as a “bad bank”.
The Co-Op has since narrowed these options to either loan portfolio sales or loan run-downs, with the former understood to be a highly probably resolution to its legacy CRE exposures.
UBS, HSBC and Morgan Stanley, as well as Allen & Overy as legal counsel, are all advising the Co-Op.
The Co-Op’s dramatic fall to near-crisis, began on 10 May after Moody’s six-notch downgrade of the Co-Op’s credit rating to “junk” status, premised on the belief that further substantial losses were expected in its non-core portfolio as “demonstrated recently by the unexpectedly significant deterioration of its commercial real estate exposures”, wrote the ratings agency in May
On the same day, Barclays Capital published an investor note which estimated that the Co-Op had a capital shortfall, ranging from £800m in its “base case” to £1.8bn in a “stressed scenario” – with today’s official declared £1.5bn gap clearly at the more severe end of the spectrum.
The Co-Op’s plight, said Moody’s in May, was exacerbated “by the low level of provisions held against its lending portfolio” and that there is an implied risk of further write-downs “and, potentially, the need for external support to maintain regulatory capital levels”.
This restructuring agreement between the Co-Op’s members, investors and bondholders appears to allay worst-case government bailout fears.
Euan Sutherland, chief executive of the Co-operative Group, said today: “Our challenge is to increase the capital in the bank by £1.5bn.
“Now there is a significant contribution by the Co-Operative Group, to the level of £1bn, to get to the level of £1.5bn total capital we need and then there is a further £500m we need, which will come from an equity swap with [junior bondholders] creating a significant minority equity share for our bondholders.
“We believe this is the fairest and most equitable plan for all involved.”
Niall Booker, chief executive of Co-operative Bank, who replaced Barry Tootell, who resigned following the Moody’s downgrade, although citing the aborted Project Verde Lloyds TSB branch bid, said: “The measures we are announcing today mean we now have a credible plan for addressing the capital shortfall we face and can turn our attention to managing our non-core assets down and restructuring our core bank.”